A common event in the finance and securities fields is distribution of securities from venture capital firms to specified participants. Typically, the distribution is of a restricted security which must be represented by physical documents. As a result, the distribution cannot be performed using entirely electronic mechanisms and instead requires comparatively inefficient manually intensive and non-standard processes which may take several weeks to complete.
When a venture capital entity (VC) wants to distribute restricted stock, the conventional practice is to first notify a facilitator for the distribution. The VC then delivers one or more physical share certificates to the facilitator. The certificates bear legend that the shares are restricted. Also printed on the security is the party to whom the security is registered, which is this case is the VC, as well as the number of shares registered to the party. The VC also provides allocation instructions identifying the limited partner participants in the distribution and the number of shares each participant should receive. Depending on the size of the distribution, the number of participants can be in the hundreds. The total number of shares referenced in the facilitator's instructions must equal the total number of shares being distributed as detailed in a required legal opinion. In addition, supporting documentation, such as stock powers, corporate resolutions, or other related documentation, is supplied. The opinion of counsel must address the total number of shares of the distribution, reference each of the participants by name, and list the number of shares that each participant will receive.
After receiving this information, the facilitator generally has two choices in distributing the securities. The first choice is to simply distribute the shares to the limited partners based solely on the instructions from the VC. The second approach is to first contact the limited partners to notify them of the distribution and get the distribution information from them directly.
The first approach is problematic in that the information from VCs is typically obtained at the fund pledge stage. The distribution can occur years after this date and the VC information is often incorrect. As a result, the distributed securities often do not reach the LP. Another problem with this approach is that, with the passage of years, the LP may have changed its mind as to what to do with the securities. Additionally, the first approach only involves sending a physical certificate to a predetermined destination—usually the LP's home address or broker—and does not provide advance notification which would allow the LP to sell the securities quickly. Because the stock price typically falls 20% or more within hours after a VC distribution takes place, the LP can suffer a significant economic loss.
The second approach is generally preferred by the limited partners. In using the second approach, the facilitator must obtain instructions from each of the participants detailing what the participant would like to do with the stock from the distribution, such as retain it in an account with the facilitator, transfer it to an account at a different broker or bank, or sell it. Getting instructions from all of the participants can be a time consuming procedure, particularly when incomplete contact information has been provided or a participant is unavailable. In addition, when the instructions result in a transfer of ownership of the stock (e.g., gifting or sales), additional legal opinions for those transfers must be obtained.
After instructions have been obtained from every participant, the participant or recipient names may need to be reformatted to conform to required industry standards and fanfolds of written or hardcopy instructions for each participant created. The instructions are processed to reflect that shares are showing on the books of the facilitator and the records in the transfer location. A copy of each of the fanfolds is attached to the certificate and the package is surrendered to a transfer agent for the distribution.
The transfer agent verifies that the received instructions are complete and, in particular, that the legal opinion agrees in every detail with the instructions furnished by the VC regarding the distribution. If the instructions are not completely acceptable, i.e., having good registrations and balanced share amounts with stock certificate versus fanfold instructions, etc., the entire transfer is rejected by the transfer agent and referred back to the facilitator for correction. Because of the need to wait until instructions from all participants have been obtained coupled with this cycle of rejection and correction, the processing time for the distribution can be several weeks.
Once the transfer agent verifies that the package (containing shares of the restricted stock, supporting documents, distribution instructions, and opinion of counsel) which has been surrendered to it is complete, the original stock certificate is canceled and one or more new physical certificates are created for each of the participants of the distribution. The new certificates have the appropriate number of shares and bear a restricted legend. The issuance or creation of the physical certificates usually requires seven to ten days and can take longer.
The securities are then returned to the facilitator. The facilitator checks each certificate to insure that it was registered correctly and for the correct number of shares. If any of the shares are to be sold or delivered to another bank or broker, the facilitator is responsible for completing that transaction by obtaining the necessary approvals, verifying a proper legal opinion approving the sale exists, etc. Delivered shares are then shipped to the designated address. Shares to be sold must be properly endorsed or appropriate stock power obtained if needed. This can also delay the settlement process. The sold shares are then re-surrendered to the transfer agent for re-registration into the name of the facilitator but without legend. The number of shares to be sold must match the amount referenced on the legal opinion and, if the amounts do not match, the transfer agent may not complete the transfer. This process can typically require seven to ten days or longer. The process can be further delayed if the facilitator receives instructions to sell shares while the shares are in transfer from the VC to the various limited partner participants since amended instructions can complicate the process and result in errors from miscommunications between the various parties involved.
Upon completion of the transfer, the shares are again returned to the facilitator which, in turn, checks each certificate for details such as registration, share amount, and issuance without legend to insure that the certificate is properly issued. The certificates can then be surrendered to the Depository Trust Company (DTC) for deposit to satisfy a fail to deliver commitment.
As will be appreciated, the conventional process for the distribution of restricted securities is cumbersome and time consuming. Distribution to participants who provide instructions immediately is delayed until the valid instructions have been received from every participant. Once the package has been provided by the facilitator to the transfer agent, even a minor error with regard to one participant will result in the entire package being returned to the facilitator for correction, further delaying distribution. In addition, when distributed shares are sold, the distributed shares provided by the transfer agent and accompanying documentation must again be returned to the transfer agent to reissue the shares without legends. As a result, it can take some time for a distribution to be completed and even participants who provide prompt instructions may need to wait several weeks before receiving the stock or proceeds from a sale.
Accordingly, there is a need for a method and system to more efficiently process the issuance of restricted securities from a VC to one or more limited partner participants. It would be a further advantage if such a method and system involved less manual intervention and provided for completion of the transaction in a shorter period of time than conventional processes.